What You Should Do If Your Stop Loss Is Hit

What You Should Do If Your Stop Loss Is Hit?

One of the great things about trading in the 21st century is that it’s much more accessible to people than it has ever been in past years. Trading in the 20th century was largely something that only the wealthy could do in order to make themselves wealthier. It was very difficult for people of average income to make any meaningful headway, since the amount of cash required to make a profit was often beyond what normal people possessed.

Today, the “price of admission” is much lower, and people can often trade in stocks, bonds, commodities and currencies themselves. This is especially true with speculative trading, such as Forex, binary options trading and contracts for difference. In these forms of trades, you don’t even need to buy or sell the assets you’re interested in, you merely speculate on the performance of the price and then reap the rewards of an accurate prediction.

However, with the lower barriers for people getting into trading, there are a lot of things to learn, and not all of them are what people expect. Of course, there are the fundamental cornerstones of trading, such as the basics of business and markets that anyone who is new should be expected to learn if they want to have any hope of success. But beyond that are the other things that people don’t necessarily discuss in depth, such as what to do when things go wrong.

Today, we’ll look at one of the things that a trader may have to inevitably face some day, and that’s what do if a trade hits the stop loss limit. First, let’s look at the basics.

What Is A Stop Loss?

In traditional trading, a stop loss, is basically the trading equivalent of an “escape hatch.” People that actually buy stocks or commodities do so with the intent to sell that asset at a higher price than they originally paid, in order to make a profit. Of course, how long it takes for a stock to rise above an original purchase price is where the art and strategy of trading comes in, as well as a bit of luck and, of course, the unpredictability of the market.

This is where a stop loss order or trade comes in. As you might imagine just from looking at the name itself, “stop loss,” this type of trading action is meant to limit the “bleeding” or loss of money make from a poor trade. It’s an essentially an admission that a particular asset and/or trade is a poor one, and a decision is being made now to “cut losses” and accept a smaller loss now, in the hopes of avoiding a much larger one later.

A perfect example of this is a corporate scandal in a publicly listed company. Someone that buys stock in a company at $80 per share, for example, might not be aware that there’s controversy brewing. However, because this person is a prudent trader, they have put in a stop loss limit at $75 per share.

Now, unexpectedly, a scandal hits with the executives where it is clear that the company has violated some financial laws. Confidence in the company plummets, and so does the stock value. Once the value of the stock has hit $75, our hypothetical trader’s stock will be immediately sold. The trader will take a loss of $5 per share, but the trader has decided that’s an acceptable loss. In this example, the trader is proved right, as the company takes years to recover from the scandal, and during those years, their stock value is hovering around $30 and only after several years and new executive changes, does it finally start to climb back up and break the $40 barrier.

Stop Loss For Speculative Trading

In speculative trading, such as Forex of binary options trading, stop loss trades, or “stop outs” also occur, but of course, now the stops go both ways. Speculative trading is not concerned so much with the final price as it is with the movement or direction of that price. That’s why for something like binary options trading, a person can make money even when the value of a stock or a currency is dropping. As long as that trader predicted the drop, there’s a chance for profit.

However, that also means that what would traditionally be good news for a traditional trader, such as a rally in the price of a currency or stock where it starts rising again, would be bad news for binary options trader making a “put trade” predicting a drop. So a stop loss puts a stop to a speculative trader’s trading action, and forces them to accept the loss of the trade they made. In binary options, this loss is always fixed, since the money put down for the trade is lost to an incorrect prediction. For a Forex trade, the loss may continue until trading stops, so it can be very important to set limits, and thus keep damage and loss under control.

What To Do Next?

This is where the real worth of a trader comes in. In some cases, especially with a very dynamic, volatile market, a stop loss may not mean much, because prices are fluctuating so wildly that the direction may reverse and money may still be made on this particular trade. On the other hand, this reversal may be an ongoing trend, and so to continue to try to make the same trade as before is going to result in a continual loss.

Depending on the type of situation the market is in, the prudent thing to do may be to simply accept the stop loss as a lesson learned. However, if you have weighed the risks, have managed them as much as you can, and your understanding of the market at this time is accurate, you may be correct in assuming a reversal is around the corner, and you can make your money back. This, however, is usually a pretty risky action to take, though the rewards can be great if you are right.